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Chapter 5: Q4BP (page 681)

From the base price level of 100 in 1981, Saudi Arabian and U.S. price levels in 2010 stood at 250 and 100, respectively. Assume the 1981 \(/ riyal exchange rate was \)0.46/riyal. suggestion: using the purchasing power parity, adjust the exchange rate to compensate for inflation. That is, determine the relative rate of inflation between the United States and Saudi Arabia and multiply this times $/riyal of f0.46. what would the exchange rate be in 2010?

Short Answer

Expert verified

The exchange rate in 2010 was $0.184/riyal

Step by step solution

01

Purchasing power parity- definition

Purchasing power parity is used to estimate the equilibrium rate of exchange between two currencies.

02

Calculation of relative rate of inflation

Relativerateofinflation=U.S.pricelevel(2008)SaudiArabiapricelevel(2008)=100250=$0.40perriyal

03

Calculation of exchange rate in 2008

Exchangeratein2008=Relativerateofinflation×Exchangeratein1979=0.40×0.46=$0.184/riyal

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